FOREX-Soaring U.S. yields pushes dollar up for 2nd day

LONDON, Oct 3 (Reuters) - The dollar climbed for a second consecutive day on Tuesday as a strong reading for U.S. manufacturing activity pushed bond yields higher, prompting investors to trim some of their extreme short bets against the greenback.

As expectations of a U.S. rate increase hardened to more than 71 percent by December from 42 percent a month earlier, according to the CME’s Fedwatch indicator, the dollar has rallied more than 3 percent over the last month.

“Divergence trades between the Fed and the (European Central Bank) are back in fashion again and until we see a fresh commitment from the ECB to scale back its policy stimulus, the dollar will continue to gain against the euro,” said Esther Maria Reichelt, an FX strategist at Commerzbank in Frankfurt.

The dollar climbed 0.2 percent to 93.74 against a broad basket of currencies, its highest level since Aug. 17. Despite its recent gains, the dollar is down more than 8 percent this year, on track for its biggest annual decline in a decade.

Global shares climbed to a record high on Tuesday after a measure of U.S. manufacturing activity for September released on Monday showed a surge to a 13-1/2 year high even as global policymakers signaled a cautious path out of record-low interest rates.

Relatively calm market conditions could encourage the ECB to extend its asset purchase scheme for a relatively longer period but with reduced monthly spending, ECB chief economist Peter Praet said on Monday.

The dollar’s surge put the pressure on carry trade currency favorites such as the Aussie and the New Zealand dollar which were down by more than 0.3 percent each.

The Australian dollar fell to its lowest in more than two months after the Reserve Bank of Australia left interest rates unchanged and gave a cautious assessment of the local economy.

Morgan Stanley strategists recommended staying short the Australian dollar against the greenback due to the diverging performance of bank shares in these countries.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Reporting by Saikat Chatterjee Editing by Jeremy Gaunt)